We have now paired the Fibonacci retracement levels with various technical tools to find trading opportunities in financial markets and in forex trading. These include Support & Resistance, Trendlines, and even Candlestick Patterns. In the previous lesson, we also saw how to place accurate take-profit orders to maximize your profits and achieve your profit targets.
But the uses of the Fibonacci support and resistance levels don’t stop there. In this lesson, we’ll show you how to set your stop-loss when you decide to use the Fibonacci levels.
The little lines that ensure that you don’t explore yourself to the risk of losing all your money in a single order when the trending direction goes against you? Yeah, it’s always good to know where to place them.
If you don’t, you’ll end up blaming the poor Fibonacci, cursing his name in your broken Italian.
Generally, we can say that many traders use Fibonacci ratios to determine where and when to enter a currency pair position. But, because the vast majority of day traders do not usually place take-profit orders to not limit the potential of their profits, the use of Fibonacci lines is more crucial in placing stop-loss orders.
Keeping that in mind, below we show you two methods to use the Fibonacci retracement tool in order to effectively place stop-loss orders.
The proper placement of the stop-loss order is crucial to managing your risk and protecting your fund if the market price goes against you. And so, the Fibonacci retracement tool can be a great help to experienced and new traders in determining appropriate stop-loss levels.
The first method is to place a stop loss right after going through Fibonacci numbers. Meaning if you planned to take a short position and enter at the 38.2% Fibonacci level, then you’d place your stop loss past the 50% Fibonacci level.
If you planned to enter at the 50.0% Fibonacci level, then you’d place your stop loss past the 61.8% Fibonacci level. And, If you planned to enter at the 61.8% Fibonacci level, then you’d place your stop loss past the 78.6% Fibonacci level.
And so on.
Pretty straightforward, right?
Let’s take a look at a 30-Minute GBP/USD chart.
As you can see in the chart above if you had shorted the GBP/USD at the 38.2% you could have placed your stop-loss order just past the 50.0% Fibonacci level. Then, if the price breaks above the 50.0% Fibonacci retracement line, you’ll be out of the position with a minor loss.
The reasoning behind this method of setting stops is that you believed that the 38.2% level would hold as a resistance point and the currency pair price would move in your direction. Therefore, if the price were to rise beyond this point, your trade idea would be invalidated.
But it’s not all unicorns and rainbows.
The problem with this method of setting stops is that it is completely dependent on you having the perfect entry.
Setting a stop just past the next Fibonacci retracement level assumes that you are confident that the support or resistance area will hold. And, as we pointed out earlier, using drawing tools on your trading platform isn’t necessarily science.
The truth is that you never really know. The market might shoot up, hit your stop, and eventually go in your direction. This is usually when you’d put a sad playlist on and turn the shower on.
We are not saying that this will happen.
But it might.
Our advice? Only use this type of stop placement method for short-term, intraday trades.
Now, if you like to be a little safer, another way to set your stops would be to place them past the recent Swing High or Swing Low.
For example, when the price is in an uptrend and you’re in a long position, you can place a stop loss just below the latest Swing Low which acts as a potential support level. In the opposite direction, when the price is in a downtrend and you’re in a short position, you can place a stop loss just above the Swing High which acts as a potential resistance level.
Successful traders typically believe that this type of stop loss placement by using the Fibonacci tool gives your trades more room to breathe and therefore a better chance for the market to move in favor of your trade.
In our case, if the currency prices were to go past the Swing High or Swing Low, it might indicate that a reversal of the trend is already in place. This means that your trade idea or setup is already invalidated and that you’re too late to jump in.
The truth be told, it is completely up to you to decide which method you should go for. Just remember that neither of the methods is a sure thing and you shouldn’t rely solely on the Fibonacci sequence as support and resistance points as the basis for your stop-loss placement.
But what both of these Fibonacci levels methods can do, when combined with other tools, is tilt the odds in your favor, give you a better exit point when market trends are against you, more room for your trade to breathe, and possibly a better reward-to-risk ratio trade.
So it’s worth a try, right?